Fairness for Puerto Rico and the “47%” (Part II)

Posted October 3, 2012

We posted an earlier article noting the unfairness of denying Puerto Ricans billions of federal dollars under the premise that Puerto Ricans alone do not pay federal income tax when, in truth, roughly half of the U.S. population is similarly situated.

But that is only one part of the story.

There is second way in which Puerto Ricans are disadvantaged under federal law because they are not treated as other U.S. citizens are under the Internal Revenue Code: they do not qualify for refundable tax credits. Refundable tax credits are often more valuable than traditional tax credits because the claimant is eligible for them evenif the amount of the credit exceeds tax liability. If a household has no federal income tax liability at all, it can still receive a refund check in the mail for the entire amount.

Unlike traditional welfare payments, tax credits are directly tied to income generated through employment. The transition to work-based refundable tax credits and away from straight welfare payments has been a consistent theme for decades, beginning with President Reagan and made famous by President Clinton, who promised to – and did – “end welfare as we know it.” This social policy shift is backed up by data as an effective strategy to move people from welfare to work, encourage continued work and career development, and provide a better home environment for children.

One notable problem with the new social safety net is that it excludes Puerto Rico. As mentioned above, Puerto Ricans generally cannot receive refundable tax credits because they are not covered by the U.S. Internal Revenue Code. Puerto Ricans do not receive any tax benefits deemed worthy enough for U.S. citizens in the fifty states – even if those other U.S. do not pay income taxes.

Two of the most prominent tax-based antipoverty programs are the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). The EITC is a refundable tax credit for low and moderate income workers paid on a sliding scale based on income and family size. In 2012, families with at least three children who earn up to $50,300/year can receive as much as $5,891. The Child Tax Credit (CTC), which was enacted to help low-income families with children, is worth up to $1,000 per child for families earning up to $16,333. Both tax credits were designed to encourage and reward work as well by offset federal payroll and income taxes.

It doesn’t take much to imagine how the EITC and CTC would play out in Puerto Rico. With an average per capita income of $16,300 per year, much of the Puerto Rican population would qualify for the EITC, and most Puerto Rican families with children would receive CTC benefits (which are currently enjoyed in Puerto Rico only by families with three or more children).

The median household income of Puerto Ricans living in a state is $36,558, so chances are good that many of these citizens receive the EITC and CTC. If they were to move to Puerto Rico mid-way through the year, and live there more than half of the year (183 days), the IRS is clear that they would forgo the EITC and CTC refunds they would otherwise qualify for as a resident of a state.

The EITC and CTC are effective at reducing poverty, and child poverty in particular. In 2010, these two refundable tax credits lifted 9.2 million people above the poverty line. The 9.2 million people included 4.9 million children – 3.3 million lifted out of poverty by the EITC and 1.6 million by the CTC. More than half of all children in Puerto Rico live in poverty, a higher level than in any state and more than double the national average.

This situation is particularly frustrating because Puerto Ricans pay federal payroll taxes. In the fifty states, the EITC and CTC can be used to offset payroll taxes, but not in Puerto Rico.

The EITC and CTC are recognized as valuable anti-poverty programs which encourages people to work, even if their income is fairly low. A single parent who works full time for minimum wage will remain below the poverty level, and the effort (and cost of child care) may make it seem pointless to work. Over the long term, though, working beats welfare as a way of life. Michael Katz, in his book The Undeserving Poor, analyzed extensive research and reported that people who got and kept a job –even at minimum wage — generally found their way out of poverty within a few years. Children of working parents, even if they remain in poverty, are more likely to work and to have higher earnings than children growing up in households supported by government payments.

The benefits of the EITC and CTC are numerous and well established. They include:

EITC expansions enacted between 1984 and 1996 were responsible for more than half of the large increase in employment among single mothers during that period – more so than welfare-based reforms such as work requirements and time limits.

Not only does the EITC encourage work among single mothers, but that work continues to pay off through future increases in earnings.

EITC expansions in the 1990s induced more than half a million families to move from cash welfare assistance to work.

Each $1,000 increase in annual income (the equivalent of a full CTC refund) sustained for at least two years increases the school performance of young children on a number of measures, including test scores.

Legislation has been proposed many times over the years to extend the EITC and CTC to Puerto Rico. Sponsors ranged from then-Sen. Hillary Clinton (D-NY) to Congressman John Mica (R-FL). The proposals were rejected, at least in part, due to the fact that Puerto Ricans don’t pay income taxes, but EITC and CTC recipients in the fifty states often don’t pay income taxes either. Cost has also been cited as a factor, but if Microsoft can take advantage of $4.5 billion in Puerto Rican-based federal tax breaks over two years, governmental priorities seem to be more important than the availability of resources.

If extending the ETIC and CTC to Puerto Rico were easy, it would have happened by now. Obtaining special treatment for special places in the current budget environment is difficult. By becoming a state, Puerto Rico would not have to fight these unique battles. As a state, Puerto Ricans would be included in the Internal Revenue Code. As it turns out, many Puerto Ricans would be better off.